Suppose that the merger is successful. But suppose that Berkshire Hathaway is considering the shutdown of PCC's military aircraft and aerospace department due to its weak growth. Despite predictions of the department's 3.1% annual growth over the next five years, some analysts believe that the department's growth will be less than 1% for the next five years, while capital expenditures will continue to increase. Keeping the military aircraft and aerospace department would result in $250 million yearly expenditures, starting the year following BRK's acquisition of PCC. There is a 35% probability that the department will produce after-tax net cash flows of $100 million and for the next five years, and then grow at 3.1% forever; there is a 65% chance that it will produce -$200 million in after-tax net cash flows in the next five years and would then grow at 0.9% forever. (The $250 million yearly expenditure already is reflected in the after-tax net cash flows. There are no changes to the year 0 cash flows because the division is part of the acquisition of PCC by BRK).

Using a WACC of 10%, what is the expected NPV of this department?

You may value just five years of cash flows or you may value future years as a perpetuity and calculate a terminal value.  (It is your choice as to how you wish to value the NPV.)

If Berkshire sees that the after-tax net cash flows are -$200 million, then Berkshire can shut down the division after the first year. Then, what is the expected NPV of this department (with the option to abandon after the first year)?

Should Berkshire Hathaway proceed with the shutdown?

Answer rating: 100% (QA)

SOLUTION To calculate the expected NPV of the military aircraft and aerospace department we need to calculate the expected cash flows for each year an... View the full answer